For most people under the age of 50, retirement is just a vague pleasant thought looming on the horizon. While they might have set up some form of a Registered Retirement Savings Plan (RRSP) to which they contribute a certain portion of their earnings, chances are they’re not actively giving it much thought (or spending much time researching).
With how shaky the economy has been (and likely will continue to be), it’s always a good idea to plan ahead and make sure you understand all there is to know about your RRSP so you can do your best to prevent any unpleasant surprises down the road.
Myth One: Every Canadian Needs One
While this certainly used to be the general opinion, things have changed within the past few years. For starters, more and more people are realizing that RRSPs simply aren’t the right choice for them. While they may still be the most popular tax-sheltering option, they’re certainly not the only one.
Many Canadians have recently turn to TFSAs (Tax-Free Savings Accounts) because they still provide a form of tax-sheltering and are better if your income is limited (or unpredictable). The general rule of thumb is that Canadians on the lower end of the income spectrum (so under $35,000 yearly) should use a TFSA while Canadians on the higher end of the spectrum should definitely stick with an RRSP. Moderate earners have to weigh the pros and cons before deciding which option will work better in the long run, but there are certain important factors they should consider:
- What tax bracket they will be in upon retirement (which will dictate how much they have to pay back to the Government)
- Whether or not their GIS (Guaranteed Income Supplement) eligibility will be threatened by using an RRSP account upon retirement.
The people who should absolutely use a TFSA rather than an RRSP account are those who expect to receive a really good pension (which could bump you into a higher tax bracket upon retirement than during your working years and would wind up costing you a significant portion of your money in taxes) and those who earn a lower income (they will be subsidized by certain government programs and need to make sure they don’t jeopardize their eligibility)
Myth Two: You Don’t have to Pay Taxes
As amazing as it would be, this, unfortunately, is not even close to true. RRSPs are government run, meaning that there’s no way they’ll let anyone get out of paying taxes. They will, however, let you defer payment until you’ve retired.
With an RRSP account, you’re able to let your savings grow without having to pay taxes (you’re given a refund each year much like you receive when filing your standard taxes each spring) but you are taxed on withdrawal. How much you have to pay back in tax is based on which tax bracket you retire in. It’s better to retire in a lower tax bracket than you were in during your working life because you have to pay back less than you would have otherwise.
Alternatively, you may end up having to pay more in taxes than you would have when you were working (you can figure it out based on your tax bracket upon retirement and how generous your pension is). The important thing is to do your research and understand exactly what an RRSP account can – and can’t – do for you.
Myth Three: You’re Entitled to the Full Amount in your Account upon Retirement
This is probably one of the biggest myths about RRSPs, and likely the most dangerous one at that. To re-iterate – RRSP accounts are fully taxable. You don’t have to pay taxes on your investments while you’re working, but as soon as you retire and go to withdraw you have to pay tax. Someone in a higher tax bracket might have managed to save up $2 million dollars, but they’ll still owe 40% of it back to to the government upon retirement unless they retire in a lower tax bracket (in which case, they’d still have to give back a significant chunk).
Never forget that, no matter what your statement says, you always own less than the stated total in your RRSP account.
Myth Four: An RRSP Tax Refund is Free Money
Actually, an RRSP tax refund is you getting back your own money (much like a regular tax refund). While the temptation to spend it on that new flat screen TV you’ve been coveting for months might be high, you’re better off resisting and dumping the refund right back into your RRSP. Think of the tax refund as money that you will have to pay back to the government upon retirement, because that’s exactly what it is. You’re going to have to pay it back eventually, so spending it on something fun now, while tempting, is going to hurt you in the long run.
Myth Five: There is No Contribution Limit
You might think that, because RRSP accounts are specifically touted as being the best way to save for retirement, there is no limit on how much you can contribute each year. You would be wrong. As a rule, Canadians can invest up to 18% of their earned income each year. Depending on how much money you make, though, you could still be limited by the cap.
If you do decide to invest more than the cap allotted, you’ll be hit with massive tax penalties (essentially undermining the entire purpose of investing in an RRSP to begin with).